The NY Fed Wins This One

The Federal Reserve Bank of New York has won the dismissal of a $25 billion lawsuit filed by former AIG (NYSE:AIG) CEO Maurice Greenberg.

Greenberg accused the NY Fed of constructing an illegal and inequitable bailout for AIG, which was once the world’s largest insurer. AIG was bailed out by the NY Fed at the height of the financial crisis in September of 2008, and to put it lightly, the decision has been swamped with controversy. The U.S. Treasury acquired close to an 80 percent stake in AIG for $182.3 billion in one of the largest bailouts of the crisis.

After the collapse of Lehman Brothers and accumulating losses from bad mortgage debt at a frightening rate, the company’s management had no choice but to accept the bailout on whatever terms the government offered. Pressed for time, the entire process was rushed and, as a result, different stakeholders and creditors received different treatment. JPMorgan (NYSE:JPM) was fully reimbursed for nearly $10 billion in debt, while unwinding billions in credit default swaps left many others in the dust.

Among those who received the short end of the stick is Maurice Greenberg, who headed AIG for nearly 40 years before his alleged involvement in an accounting scandal led to his removal. He remains chairman and managing director of a financial services company called Starr International, which with a 12 percent stake was AIG’s largest shareholder.

By nearly any definition the bailout of AIG was distressed, and Greenberg argues that the Fed’s conditions were not only inequitable, but comparable to a loan shark. The $85 billion credit line extended to the collapsing insurer came loaded with a 14.5 percent interest rate.

The decision issued by U.S. District Judge Paul Engelmayer serves as an endorsement for the NY Fed’s actions, but many still find the government’s actions unsavory. Less troubled bailouts such as the government’s intervention with GeneralMotors(NYSE:GM) were not so pressed for time, and creditors and stakeholders received much better treatment. The judge determined that the NY Fed acted in the best interest of the U.S. economy and prevented what would otherwise have been a far more devastating financial collapse.

The government’s exit strategy remains unclear. The case with GM seems to be positive, and the government is simply waiting for the stock price to climb enough that it can sell its stake without taking on too large of a loss. Since the bailout of AIG, the government has reduced its stake to about 16 percent, returning the equity that Greenberg claims the government stole.

Greenberg has a separate case filed with the U.S. Court of Federal Claims related to the AIG bailout that is still open.